Natco Pharmaceuticals 3QFY14 results update

Natco Pharmaceuticals 3QFY14 results were above estimates on all operating parameters, with margin of 26.5% (up 100bpsYoY, 220bpsQoQ) being the key highlight. Gross margins expanded sequentially and underlines the results of Natco’s efforts to improve margins by moving out of unviable (domestic non-oncology business, US retail) businesses. We upgrade FY14/15E earnings by 10%/12% respectively, factoring in the strong 9MFY14 performance. We continue to retain our positive stance on the company given its strong US pipeline and potential launch of Copaxone. We introduce FY16 estimates and increase our target price on the stock to Rs1,064, rolling forward our multiple for the base business at 14xFY16E EPS of Rs47.4 (15xFY15E EPS earlier) and valuing the Para IV pipeline at Rs401/share. We retain Buy on the stock.

Strong 3QFY14 Performance: NPL’s 3QFY14 earnings were above our/Bloomberg consensus estimates by 26%/23%, respectively, following strong operating performance. Revenue, at Rs2bn, was 7% above our/consensus estimates respectively and was driven by strong growth in the domestic oncology business (up 69%YoY albeit on a low base) and the exports formulations business (up 65%YoY, lansoprazole and rizatriptan together contributed Rs135mn and were not there in the base period). API business declined 18% YoY. EBITDA margin stood at 26.5%, 240bps above estimates, led by gross margin improvement (up 380bpsQoQ). Tax rate stood at 28% higher than our full year tax rate assumption of 24% and is likely to come down in 4QFY14. Natco expects Fosnerol launch in CY15 and lansoprazole OTC launch in end of CY14. Guwahati plant is likely to be commissioned from April-2014, owing to which tax rate is likely to be lower in FY15 and FY16 (we have assumed 21% tax rate in FY15/16E respectively).

Teva’s approval for 40mg/mL unlikely to impact estimates materially: Teva’s approval for a longer-acting version of Copaxone (multiple-sclerosis drug with US market size of ~US$3.5bn) in 40mg/mL (three times a week dosage, currently sells 20 mg/mL daily injection) is unlikely to impact our estimates materially, as we have already factored in a lower market size of US$2.9bn and our Copaxone estimates are thus insulated, to the extent of a 17% shift in the existing market to the higher version. Teva intends to shift nearly half of its patients to the higher dosage. We believe a lot will depend on how the 40mg/mL is priced (this will be key as a significant discount to the 20mg/mL may expedite the patient shifting) and when Natco gets an approval (an early approval will help limit Teva shift its existing patients to the higher dosage). We are currently valuing Copaxone at Rs337/share assuming a launch in May-2014 (refer exhibit 1 for valuation details).